Access to Green Finance Project (RRP TAJ 45229) Supplementary Document 17

FINANCIAL MANAGEMENT ASSESSMENT REPORT (MICROFINANCE INSTITUTIONS)

A. Executive Summary

1. As of February 2013, there are 126 licensed microfinance institutions (MFIs) and microfinance banks in Tajikistan. They provided microcredit with varying purpose, loan size, outreach, efficiency, self-sufficiency, profitability, and impact. The Access to Green Finance project will help meet demand for green finance, while promoting efficient financial intermediation consistent with the ADB requirements. The Project Management Unit (PMU) under the MOF will establish a Green Finance Fund in a commercial bank acceptable to the MOF and will lend $8.8 million equivalent in somoni to eligible MFIs for tenors of 5 years, at an interest rate equal to the National Bank of Tajikistan (NBT) refinancing rate, for onlending to subborrowers. The PMU will select and allocate this sum among MFIs in accordance with agreed selection and allocation criteria,1

subject to ADB concurrence. ADB conducted financial due diligence on several MFIs and found that Arvand, IMON, Humo, and Oxus meet the agreed selection criteria. The final selection of MFIs for participation under this project will be conducted by the PMU in accordance with the guidelines set forth in the Project Administration Memorandum (PAM) and will be subject to ADB’s concurrence.

2. Among the 4 MFIs referenced above, Humo and Oxus are licensed by NBT as microloan organizations (MLOs) and hence can only perform lending activities. IMON International and Arvand are registered as microdeposit organizations (MDOs) and hence can perform both lending and deposit-taking activities. Oxus was one of the implementing agencies that received a loan under a previous ADB project, the Microfinance Systems Development Program (No. 33040). IMON has been a recipient of loans from EBRD, IFC, and other institutions; Arvand and Humo have been recipients of loans from EBRD, KfW, and other institutions. All 4 of these MFIs meet the necessary financial ratios (footnote 1) and have successfully completed ADB's due diligence for financial intermediaries (Table 1). ADB’s integrity due diligence found no evidence that they have engaged in money laundering or other illegal activities.

Table 1. Assessment of Tajikistan MFIs with Agreed Upon Requirements

Item Requirement IMON (2012)

Arvand (2012)

Humo (2012

Oxus (2012)

Meeting all NBT prudential requirements? Yes Yes Yes Yes Yes Equity / Total Assets ≥ 12% 24.2% 13.6% 23.2% 20.3% Return on Assets (ROA) > 0% 6.5% 5.0% 9.0% 3.4% Return on Equity (ROE) ≥ 10% 26.2% 30.6% 38.7% 16.7% Intermediation Cost Ratio (Operating Expenses/Total Assets)

< 33% 26.8% 28.8% 32.9% 31.2%

PAR (Portfolio at Risk) > 30 days < 5% 2.2% 0.3% 1.2% 0.7% Write-off Ratio < 5% 1.0% a 0.1% 1.3% a 1.2% a

1 In order to be eligible to participate, an MFI must (i) comply with capital adequacy requirements and other

prudential requirements established by the National Bank of Tajikistan; (ii) have equity equal to at least 12% of its total assets; (iii) have a ratio of return on assets (ROA) greater than zero; (iv) have a ratio of return on equity (ROE) of at least 10%; (v) have an intermediation cost ratio of less than 33%; (vi) have a portfolio at risk (PAR) over 30 days of less than 5%; (vii) have a write-off ratio of less than 5%; (viii) have corporate, financial, and management and governance practices acceptable to ADB and MOF; (ix) have satisfactorily completed ADB’s integrity due diligence checklists; and (x) have substantial outreach in low income urban and rural areas. These requirements must be maintained throughout the project implementation period. An MFI that fails to meet one or two of criteria (ii)–(vii) but still has strong implementation capabilities may be considered for participation if it submits an action plan to attain them, as long as it complies with criteria (i) and (viii)–(x). MFIs will also be required to submit audited financial statements for the 2 years prior to entering into a subloan agreement.

2

Item Requirement IMON (2012)

Arvand (2012)

Humo (2012

Oxus (2012)

ADB financial intermediary due diligence ok? Yes Yes Yes Yes Yes ADB integrity due diligence ok? Yes Yes Yes Yes Yes Substantial outreach in rural areas? Yes Yes Yes Yes Yes Summary Ok Ok Ok Ok Ok

a 2011. Source: Asian Development Bank staff.

3. The 4 MFIs' financial statements are prepared and maintained according to International Financial Reporting Standards (IFRS) and are audited according to International Standards on Auditing (ISA) by NBT-accredited audit firms (for 2012, Baker Tilly [Arvand and IMON], BDO [Humo], and Finconsult [Oxus]). ADB's project agreements with the selected MFIs will include a provision for their external auditors to certify that ADB's loan funds were used by them only for the permitted purposes. 4. The 4 MFIs' internal audit systems are appropriate to their organizations. The internal audit departments (IADs) report independently to audit committees under their boards of directors and are structured based on the relevant articles of the microfinance law and their internal audit policies. The 4 MFIs also diligently apply reasonable credit appraisal procedures. All four have constituted credit and/or credit approval committees, which in most cases include board members for the purpose of assessing and approving high-value loans. All 4 MFIs have also established asset-liability management committees which ensure that asset-liability mismatches are properly assessed and managed. Policies and practices are also in place for treasury and other operational functions. 5. ADB's loan will finance subprojects for the purchase of smart green energy solutions (SGES). Subprojects will comply with the requirements of Tajikistan's environmental legislation and regulations and conform to ADB's safeguards policies. MFIs will finance only those subprojects which have minimal or no adverse social or environmental risks. Subprojects that fall under ADB's environmental and social safeguard categories A and B or which specifically require environmental assessment clearances by the Government of Tajikistan will not be financed under the project. ADB's prohibited investment activity list will apply. 6. A key risk that participating MFIs will face is credit risk. The credit risk of lending for SGES can be managed through careful client selection and assessment. The low levels of delinquency and write-offs indicate evidence that MFIs manage credit risk well. The risk will be distributed among a relatively large number of customers since ADB-financed loans for SGES are expected to average around $2,000 and may not exceed $5,000. MFIs selected to participate in this project will be allowed to set their interest rates for SGES loans based on full cost and risk recovery (i.e., taking into account their cost of capital, administrative expenses, and expected loan losses).

B. Project Implementation Units (PIUs)

7. The members of the PIUs for each selected MFI are identified in the PAM. Staff will be trained and supported to ensure they can correctly assess and manage credit risks, safeguards, and integrity processes to ensure project results.

3

C. Funds Flow and Disbursement Arrangements

8. ADB's imprest fund and statement of expenditure (SOE) procedures will be utilized. Arrangements on funds flow and ADB procedures for loan withdrawals and SOE procedures are detailed in the PAM.

4 Appendix 1 of Supplementary Document 17

FINALIZED FINANCIAL MANAGEMENT ASSESSMENT QUESTIONNAIRE (FMAQ) BY FOUR MFIs

A. MDO IMON International

Appendix 1 of Supplementary Document 17 5

6 Appendix 1 of Supplementary Document 17

B. MDO Arvand

Appendix 1 of Supplementary Document 17 7

8 Appendix 1 of Supplementary Document 17

C. MLO Oxus

Appendix 1 of Supplementary Document 17 9

10 Appendix 1 of Supplementary Document 17

D. MLO Humo and Partners

Appendix 1 of Supplementary Document 17 11

12 Appendix 2 of Supplementary Document 17

RISK ANALYSIS SUMMARY TABLE Risk

Assessmenta

Proposed Mitigation Control Risks 1. Implementing Agencies

(ADB has completed due diligence on the 4 MFIs referred to in this appendix as examples of the MFIs to be selected)

L ADB has undertaken due diligence on the operational and financial soundness of the MFIs using eligibility criteria and found them safely solvent, comfortably liquid, satisfactorily profitable, and adequately efficient. The same due diligence will be undertaken by the PMU for all candidate MFIs under consideration, and the due diligence for those MFIs proposed for subloans will be validated by ADB. Each MFI will be required to report project progress on a quarterly and annual basis. ADB review missions will also assist the MFIs where weaknesses in capacity are identified during implementation.

2. Funds flow/disbursement arrangements. Need for Imprest Accounts Need for the Statement of Expenditure

M To monitor the imprest accounts, the selected MFIs are required to submit (along with its loan withdrawal applications to ADB) a reconciliation statement and copy of its bank statement which are reviewed by ADB Controllers. ADB Controllers Department will conduct disbursement and SOE review mission to check the veracity of the SOE records. ADB may also request the submission of supporting documents on a sampling basis.

3. Staffing L The MFIs proposed by the PMU will be assessed to confirm appropriateness for the project. The staff of each selected MFI's project implementation unit (PIU) will be given intensive briefing and periodic spot training on ADB disbursement procedures, loan requirements, and details of the Project Administration Manual (PAM).

4. Accounting Policies and Procedures

L The MFIs proposed for the project will have reviews of their accounting policies and procedures to ensure they are adequate for the scope and scale of their operations. The participating MFIs will prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) and have them audited in accordance with International Standards of Auditing (ISA). They will follow IFRS principles for all aspects of their operations. These standards meet ADB's requirements.

5. Internal Audit

L The participating MFIs' internal audit systems will be assessed before acceptance to ensure they are appropriate to their organizations. The internal audit departments will report independently to their boards of directors. The participating MFIs will have in place diligent credit approval practices to ensure adequate check and balances in loan appraisal and approvals. Checks and balances will also be in place for treasury and other operational functions.

Appendix 2 of Supplementary Document 17 13

Risk Assessmenta

Proposed Mitigation

6. External Audit

L The MFIs are required to have their financial statements and project accounts audited annually in accordance with International Standards of Audting (ISA) by an auditor acceptable to ADB and meeting the project's requirements. The PMU will also maintain its financial statements as required by ADB and have them audited by independent external auditors acceptable to ADB. External auditors' reports are always issued within 3 months of the close of each fiscal year. To ensure that the ADB's loan funds were used only for the intended purposes, ADB's project agreements with the MFIs will include a provision for their external auditors to certify that ADB's loan funds were used by them only for purposes authorized by the grant agreement. Likewise, the PMU’s independent external auditors acceptable to ADB will also be required to certify that the PMU’s expenditures were used for purposes specifically authorized by the grant agreement.

7. Reporting and Monitoring

M During project implementation period, the participating MFIs will be required to submit to ADB (i) quarterly progress report and (ii) an annual monitoring and evaluation report. Templates for these reports along with the detailed monitoring criteria will be given to the MFIs before implementation starts and will be discussed with the PIU of each MFI.

8. Information Systems

L The participating MFIs will be required to have management information systems (MIS) adequate to their needs. The MIS generally will cover portfolio quality, treasury operations, and other support operations.

Overall Control Risk L

Inherent Risks Legislative risk. Parliament may reject tax waivers and exemptions on selected SGES products proposed by the government. Project complexity. Successful financing of many SGES products requires cooperation between MFIs, NGOs, and suppliers and/or manufacturers of SGES products.

M

M

If requested, ADB will prepare written analyses of the benefits of the wide use of SGES products and the economic benefits accruing from the proposed tax waivers and exemptions. The PMU will have a full time staff member who will be responsible for instigating the coordinating the necessary cooperation. The TA will also provide consultancy support for these cooperation development and coordination activities.

a H = High, M = Moderate, L = Negligible or Low.